KeithGram: Yield Chasers

A crisis is brewing in Spain.

Spanish banks have borrowed short to lend long.  This means they take in money from depositors (i.e. borrow) and make long-term loans, such as mortgages.  The catch is that depositors can withdraw their money but the bank cannot call the loans.

Imagine if you borrowed money from Joe to lend to Mary.  You promise Joe he can ask for his money back on the first of every month, and you pay him 1% interest per annum.  However, your contract with Mary says she will repay you 1/360 of the principal every month for 30 years.  Mary pays you 4% per annum.  You are locking in a profit for every month this continues.

You are happy until Joe demands his money back.  Then panic sets in.  You must call John, Jim, Jack, and Jonathan to beg to borrow their money.  And you will offer higher and higher interest rates.

At that point, you don’t care about profits.  You are fighting for your life.  It is analogous to drowning.  You don’t care if you lose your money, so long as you can get to the surface and breathe air again.

So it is with banks in Spain.

Central banks have destroyed savers with zero interest rates.  But people should not fall into the trap of chasing yield.  High yield in a zero-interest environment means only one thing.  High risk.

Those who lend to Spanish banks today are chasing a Siren but they will end up dashed to pieces on the rocks.  See: “Deposit Wars” an Act of Desperation by Spanish Banks; Bankia Déjà Vu

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